The Fed Blog

Wednesday, May 9, 2012

Europe's Wonderland

The Europeans have had the best governments money can buy. Their elected leaders have provided them with all sorts of wonderful social welfare benefits. Many Europeans are employed by their governments to provide those benefits to their needy fellow citizens. Those who cannot find a job, or are too depressed to look for one, are provided with extremely generous unemployment benefits. Retirement benefits are great, and early retirement is the norm. Life has been very good in Europe.

Of course, that all costs lots of money. That’s why income tax rates are so high in Europe. On top of those rates, Europeans pay significant value-added taxes on the goods and services they buy. Yet there has been an ever-widening gap between government spending and revenues. That’s partly because Europeans have responded to their exorbitant tax rates with widespread tax avoidance.

The spending of European governments has ranged between 40% and 60% of GDP for many years. The revenues collected by these governments have ranged between 30% and 50% of GDP. The resulting deficits have led to rapidly rising ratios of government debt to GDP.

Attempts to bring back some fiscal sanity, led by Germany’s Chancellor Angela Merkel, are now widely caricatured as fiscal “austerity.” In my opinion, the only way to fix Europe is to slash government spending, reduce tax rates, enforce tax collection, and deregulate labor markets. Instead, enraged European voters are rising up against austerity and voting for the status quo. They haven’t indicated who they expect will pay the bills. However, they must be counting on either the Germans to pick up the tab or the ECB to implement more rounds of the LTRO.

European politicians who signed on to the “fiscal pact” promoted by Germany late last year are losing their jobs. Those favoring a “growth pact” are winning support, though they have no specific plan yet and certainly no way to finance it once it is specified. Also gaining support are various left- and right-wing fringe groups that tend to promote anarchy as the most effective way of overthrowing the established order and replacing it with their disorder.

Europe is at risk of devolving from an economic and monetary union into a disunion of failed states. The Greeks are unable to form a coalition government after the two major parties lost significant support to fringe parties over the weekend. They may need to have another round of elections. The remote chance of Radical Left leader Alexis Tsipras forming a coalition faded on Tuesday when New Democracy leader Antonis Samaras promptly rejected his demand to scrap Greece’s bailout plan, warning such a move would drive Greece out of the euro: "Mr. Tsipras asked me to put my signature to the destruction of Greece. I will not do this. The country cannot afford to play with fire."

(According to Greek mythology, Prometheus stole fire from Zeus and gave it to mortals. Zeus then punished him for his crime by having him bound to a rock while a great big eagle ate his liver every day only to have it grow back to be eaten again the next day. During the Greek War of Independence, Prometheus became a figure of hope and inspiration for Greek revolutionaries.)

The Dutch government collapsed on April 23, and elections aren’t scheduled to be held until September 12. France has a new Socialist president, but upcoming Parliamentary elections could weaken his ability to implement his agenda. In Spain, the central government is struggling to take charge of regional governments that have pursued their own reckless fiscal policies. Even Chancellor Merkel may lose some of her political support in upcoming state elections.

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ABOUT: Dr. Ed Yardeni is the President and Chief Investment Strategist of Yardeni Research, Inc., a provider of independent investment strategy and economics research. This blog highlights excerpts from our research service, which is designed for investment and business professionals.